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December 10, 2013

The State of Fiduciary After 1,640 Days: Time for a Reset?

Today is the 1,640th day since the Obama Administration recommended that broker investment advice be fiduciary advice. Advisors can be forgiven for feeling worn out by the incessant fiduciary talk and looking for a moratorium on anything fiduciary related.

Before doing so, however, a quick look at November’s vote by an advisory group of the SEC is instructive. While heralded as a step forward by some, the vote and comments surrounding it underscore the precarious state and the considerable risk of SEC rulemaking on the fiduciary standard. Five years after Lehman a reset may be in order.

Yet questions abound. Given SEC Chair MaryJo White's various statements on the fiduciary topic, rule-making under her watch is not a certainty. More pointedly, the question of whether prospective rulemaking would actually be a net benefit to investors, given overwhelming industry pressures to neuter the fiduciary standard in rulemaking, needs to be addressed.

The IAC recommendation focuses attention on the risks and rewards of rulemaking, and starts by underscoring that the SEC has choices. The SEC may make rules either through the Investment Advisers Act or through Dodd-Frank. Or, critically, the SEC may make no rules at all, and abandon a uniform standard. The IAC recommends "rulemaking under the Investment Advisers Act to narrow the broker-dealer exclusion from the Act."

If the SEC proceeds through the Investment Advisers Act, the key advantage is, the IAC notes, that "there would be minimal risk that existing investor protections would be weakened as a result of efforts to accommodate the broker-dealer business model." In this approach, broker-dealers could simply avoid regulation under the Advisers Act by limiting themselves to the selling products and, critically, "avoiding holding themselves out as advisers or as providing advisory services."

The IAC considers rulemaking under Dodd Frank an inferior, yet viable, option. Inferior because Dodd Frank’s language "poses some significant implementation challenges." The heart of these challenges is reconciling Dodd Frank's permissiveness of certain broker practices—such as earning commissions and selling proprietary products—as not presumptively fiduciary breaches, with the Dodd Frank requirement that the standard be "no less stringent" than the Advisers Act.

It concludes, "Depending on how certain of these provisions are interpreted and enforced... such an approach could result in a significant weakening of the existing Advisers Act standard." Thus the IAC insists this option include "an enforceable principles-based obligation to act in the best interest" of clients, to ensure that, consistent with the Dodd Frank mandate, "the standard is no weaker than the existing Advisers Act standard."

The Institute for the Fiduciary Standard supports the IAC recommendation on rulemaking through the Advisers Act, yet it also underscores again, as it has before, the risk of rulemaking through Dodd Frank given SIFMA's seat at the table and blunt views on what it believes fiduciary conduct should mean.

We are counseled throughout life to pick our partners wisely. The (unstated) practicality in 2013 is that rulemaking through Dodd Frank requires accepting SIFMA as a "partner" at the table, and one who is holding some pretty good cards. The associated risk of this practicality is large and far too great to justify whatever a sober analysis suggests is the potential reward.

The views of our partner, SIFMA, are not just at odds with views of jurists or groups with longstanding traditions espousing the fiduciary standard.

Differing views can be accommodated and middle ground identified. Groups such as the Institute for the Fiduciary Standard, the Consumer Federation of America, AARP, Fund Democracy, the North American State Securities Administrators Association (NASAA) and the Investment Advisers Association (IAA) have espoused views and offered recommendations base on certain facts and circumstances and understandings of the marketplace that, for the most part, seemed settled or beyond dispute. Or so we thought.

Notable are SIFMA's views in a 2011 letter to the SEC, in which it chides SEC staff guidance that encourages that conflicts be avoided. It also advocates that investors actually benefit from conflicted brokerage advice, and urges protocols that ensure brokerage disclosure may be delivered quickly and efficiently to brokers' customers; essentially, a "rapid fire" disclosure protocol.

It’s not that SIFMA's views are at odds with the views of fiduciary advocates; its reality is at odds with circumstances and understandings that are generally considered settled. When was the last time an advisor, friend, or colleague looked at you and said, in the spirit of the character in the movie "The Graduate" who counseled Dustin Hoffman’s character about getting involved in plastics. "Conflicted advice. Seek conflicted advice!"

These views are not isolated examples at the periphery of SIFMA's fiduciary view; rather, given their centrality and prominence in SIFMA advocacy, they are best understood as its core tenets.

The 2008 Rand Report findings and the substantial number of independent research reports (before and after) testifying to investor misunderstandings may be the classic example where certain understandings seemed settled but apparently are not. That many investors seriously misunderstand what they pay for and what they receive in return, for the services of brokers and advisors, is generally accepted as being both true and harmful to investors.

SIFMA's most recent statement, an Oct. 11, 2013 letter responding to the IAC proposal suggests otherwise. SIFMA opines that "there is no evidence that investors are being harmed by the current suitability standard.” It furthermore suggests that among the "harms" which it believes are "alleged" and not substantiated, is harm from "an investor mistakenly believing that a financial advisor is acting in his best interest when that is not the case..."

If the SEC were to proceed with rulemaking, is there any reason to suppose, on its face, that the SEC would choose the IAC recommendation and avoid rulemaking through Dodd Frank over the SIFMA recommendation to proceed through Dodd Frank?

Fiduciaries rightly pride themselves as gatekeepers, overseers and protectors of their clients’ assets. Integral to this responsibility is a skill in and passion for rigorous risk analysis. We need to apply our risk analysis skills to what could be the most important regulatory action in decades. We need to reexamine, with an open mind, the risks and rewards of the SEC proceeding with rulemaking. Then we need to act on whatever we conclude.

There is much at stake; there is time to make a difference, even after 1,640 days.

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